The Security Act 2.0 gives savers 72 and under an extra year before you have to withdraw money from your retirement accounts. But just because you can delay your required minimum distribution (RMD) doesn’t mean you necessarily should, financial advisors say.
Passed late last year, the comprehensive retirement law raised the RMD age to 73 in 2023, up from 72. Beginning in 2033, the RMD age will increase to 75.
The changes most directly affect those turning 72 this year, who would otherwise be required to take their RMDs by April 1, 2024. (The IRS gives first-timers a grace period until spring of next year; in all subsequent year, RMDs must be taken by the end of the year.) Your RMD is calculated by dividing your retirement account balance as of December 31 of the previous year by what the IRS calls your “life expectancy factor.” The received amount is counted as income; you must withdraw it from your account and you will owe tax on it. RMD rules apply to traditional IRAs as well as employer-sponsored retirement plans such as 401(k)s and 403(b)s.
Most Americans don’t have the luxury of waiting, because they need withdrawals from their retirement accounts to live. But among those who can afford to wait, delaying is not always the best move. If you delay your RMD and your retirement account balance increases, you’ll have to withdraw a larger amount the following year. (Even if your account balance stays the same, you’ll need to take out more since the life expectancy factor will be lower.) The extra income could increase not only the amount you pay in income taxes, but also your Medicare premiums. .
“Some of the old rules, like letting your tax-deferred accounts marinate as long as possible, don’t always apply,” said Josh Strange, a certified financial planner and president of Good Life Financial Advisors NOVA in Alexandria, Va.
Without a crystal ball showing how the markets will behave this year, it’s impossible to say whether current 72-year-olds could benefit from deferring RMDs for a year, all other factors being equal. (Market participants polled by Barron’s expected the S&P 500 to end the year higher than current levels). But what if all other factors are not equal? Let’s say you’re 72, expect to retire this year and be in a lower tax bracket next year. In that case, deferring your RMD to 2024 would probably make sense. On the other hand, if you plan to sell your primary residence next year and realize more than $250,000 in capital gains (or $500,000 if you’re married filing jointly), then you may want to start your RMDs this year to avoid potentially next year, add a larger RMD along with your capital gains. This could cause higher Medicare premiums for you down the road.
Instead of waiting until you’re at the RMD threshold to do your tax planning, you’ll have a better chance of managing the tax consequences if you start years in advance. “The sooner the better,” said Chris Yamano, a partner at Creve Advisors in Scottsdale, Arizona. One popular move is to convert a Roth after you retire but before you reach RMD age. You’ll likely be in a lower tax bracket during that time, so converting your traditional IRA to a Roth IRA — either all at once or spread over several years — will mean you’ll owe less tax on the converted amount than if you did it when you were in a higher bracket. .
There could also be benefits to withdrawing from your retirement accounts sooner than you planned. For example, if withdrawing money earlier would allow you to delay claiming Social Security until age 70 to receive your full benefit, then it might be worth considering. Lawrence Kotlikoff, a Boston University economics professor who sells Social Security optimization software, ran a scenario of a hypothetical high-earning couple in their early 60s who planned to retire and claim Social Security at age 64. The couple lived in New York and planned to wait until 75 to take their RMDs. Using his MakiFi software, he found that waiting until age 75 would be less tax-efficient for this couple than starting a smooth withdrawal at age 64, since their reduction in state taxes and Medicare premiums would exceed the increase in federal taxes they owed from earlier withdrawals.
“This is a very complex calculation,” Kotlikoff said. “It’s really very individual.”
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